Talks over a bigger US government stake in Citigroup could put Singapore's sovereign wealth fund in the difficult position of having to decide whether to convert its beaten-down Citi stake into common stock and wind up owning more of the troubled bank than it might want.

Elsewhere in Asia, banking regulators will likely look closely at the impact of a partial nationalization on banking units partly or wholly owned by Citigroup.

And for Citi units in Asia, some of which were recently recapitalized by the parent company, the question will be whether those fresh funds will now flow back to the US as the cash-strapped lender moves to pare back its presence overseas.

Citing people familiar with the matter, The Wall Street Journal reported early Monday that Citigroup is in talks with US federal officials about converting a substantial chunk of the government's $45bn (€35.2bn) in preferred shares into common stock. If the plan goes ahead, the government could wind up holding as much as 40% of Citigroup's common stock, although bank executives hope the stake will be closer to 25%, these people said.

The Journal reported that Citigroup officials also hope to persuade such private investors as the Government of Singapore Investment Corp., Abu Dhabi Investment Authority and Kuwait Investment Authority to follow the US government's lead in converting some of their stakes into common stock. That would further bolster an increasingly pivotal measure of banks' capital known as tangible common equity.

For Singapore's GIC, which earns an annual coupon of 7% on its preferred stock, converting its holding into common stock doesn't remove the risk of being diluted or wiped out if Citigroup needs another capital injection or is nationalized by the US government.

GIC has no current plans to convert the preferred shares it owns in Citigroup Inc. into common stock, two people familiar with the situation said Monday.

"If GIC is to convert into common stock, the deal must be sweetened quite a lot. They want to make sure that their return will be equal or above the coupon," one of these people said.

Related

In January 2008, GIC invested $6.88bn in convertible preferred securities of Citigroup, which at the time would have given it a 4% stake in the bank if converted to common stock. According to a Securities and Exchange Commission filing late last month, GIC now owns a beneficial 5.3% stake, or 303.8 million shares, in Citigroup. These include preferred shares that can be converted into 261.1 million common shares. Based on Citi's $1.95 closing price Friday, the stake is worth $592.4m.

Citi May Scale Down Asian Ops If Nationalized

Citigroup's ability to support its offshore businesses could be curtailed by a bigger US government stake in the bank. Indeed, analysts fully expect a largely US-owned Citi would end up selling foreign units, including some Asian operations.

One investment banker says Royal Bank of Scotland Group PLC's recent experience after the UK government took a 57% stake offers clues to what might happen at Citigroup. The Wall Street Journal, citing people familiar with the matter, reported Friday that RBS hired Morgan Stanley to explore the sale of Asian retail and commercial operations and Australian operations it acquired when it bought part of ABN Amro Holding NV in 2007.

In Citi's case, "of course, it will depend on what is seen as core and non-core as a government-owned bank," the banker said.

In Japan, Citigroup is already seeking to unload Nikko Cordial Securities Inc., one of the country's top brokerages, after spending roughly ¥1.5 trillion in January 2008 to make it a wholly owned subsidiary.

In December, Citigroup injected $800m into Citibank Korea Inc.—the largest Citigroup subsidiary in Asia-Pacific in terms of capital and assets—in order to raise its capital base. The move was spurred by South Korea's banking regulator. At the time, Citi said it was the only regional unit to receive a capital injection and that the funds didn't come from the US Treasury Department's Troubled Asset Relief Program.

Mr. Pogson said he's increasingly advising corporate clients "to ensure that they include a locally domiciled bank in their panel of banks from which they finance themselves."

Moderate Reaction From Markets

News of the Citi-US talks briefly supported Asian stock markets on Monday, with some bourses turning higher or coming off their early session lows. US stock futures moved up 1.0% in screen trade.

"After this Wall Street Journal report the market has bounced, indicating a bit of short-covering," said Patersons Securities' Sydney retail head Chris Blair. "It is the uncertainty that the market (has been) selling. If the US government is looking at a 40% stake, although not largely positive, the market will have that certainty and reel in some short positions."

The Nikkei 225 ended down 0.5%, though off its lows, and Australian shares closed 1.5% lower. South Korea's Kospi Composite ended up 3.2% and Hong Kong's Hang Seng Index was up 3.9%.

The Citigroup report boosted appetite for risk in the currency market. The euro gained sharply against both the yen and U.S. dollar. There were also gains for higher-yielding, and thus riskier, currencies like the Australian dollar and the New Zealand dollar rising. U.S. Treasury prices slipped.

"Always this kind of news is pressure on the Treasury market," said Kazuaki Oh'e, executive director of debt capital markets at CIBC World Markets in Tokyo. Investors had piled into Treasurys on Friday as fears mounted about the future of Citigroup and Bank of America, and "now we're seeing an unwinding of that move."

—Write to Costas Paris at costas.paris@dowjones.com and Nisha Gopalan at nisha.gopalan@dowjones.com; Jin-Young Yook and Rosalind Mathieson contributed to this story.